Unless you represent your company’s pension fund, or are an incredibly wealthy individual, you will not qualify to participate in a hedge fund or need to choose a hedge fund accountant. Nonetheless, if you would like to understand how your company’s pension fund is run, you may be very interested in finding out how a hedge fund works. A hedge fund manager controls an actively traded account or fund, for a group of individuals. Shares in the fund are purchased by investors wishing to take part in the fund. Typically a hedge fund manager will also buy shares and participate in his own fund. This connects his fortunes to those of his clients.
A hedge fund is different from other funds in the way it is handled. For instance, a mutual fund is designed to be stable with steady, moderate return on investment. Both a hedge fund plus a mutual fund are open-ended, meaning at any time during your participation you can chose to withdraw or deposit funds. By investing in reliable, positive-growth companies, utilities for instance, a mutual funds principal increases. It only buys stock, it does not sell short. More aggressive mutual funds may be targeted toward higher growth companies, like the technology sector, for a little more return with a bit more risk. In a recession a mutual will often lose money. As a result of economic downturn this decade, retirement accounts based on mutual funds have taken a substantial hit.
In contrast, a hedge fund runs very different. The hedge fund has the freedom not only to purchase stocks long, but to sell stocks short in the case of an economic downturn. This means that a positive return on investment (ROI) can be realized regardless of the state of the economic climate. However, the basic law of finances that a higher return always comes at the cost of a greater risk binds a hedge fund. The bigger risk of a hedge fund comes from the shorting approach. When an investor purchases long, they will never lose any more than their financial investment. However, when an investor purchases short, he can lose a lot more than his investment and actually gain a debt. The expertise for controlling this risk and properly forecasting economic growth and downturns is much more difficult than simply choosing high-growth companies. That is why, it is critical to examine the credentials of a hedge fund accountant.
Leverage is another tactic employed by hedge fund managers. Leveraging is when you purchase a specific stock for only a fraction of its actual value. When purchasing using this method the stockbroker will make up the difference, in exchange he expects that the price of the stock will not change enough that his participation would be endangered. The leverage is the ratio of the stock value to the investment amount. If the leverage was 2:1, then a growth in stock of 1% would yield a return on investment of 2%. Hedge fund professionals can operate with a leverage of 10:1 or even more. This means that substantial gains can be realized. It also means that there is a real risk of huge losses.
There are two things that investors use to qualify a successful hedge fund accountant: long-term ROI and draw downs. A good minimum time horizon is normally 20 years. In that time, you can examine the ROI from start to end, in other words, the present day return on an investment made and held 20 years ago. It’s also wise to watch negative deviations from a straight upward line of growth. These digressions are called draw downs. A draw down greater than 20% signifies considerable risk in the account.
One must do so much more research to fully understand hedge funds. Nonetheless, this information will get you started in understanding basic hedge fund operation.
